This article explains how a real estate licensee may write off home office expenses, plus the brokerage activities needed to establish a home office for expensing costs—as well as which activities classify a home office as a licensee’s principal place of business.

Qualifying for a deduction

As much of the real estate world transitions to online or remote work in the midst of the coronavirus (COVID-19) pandemic, more and more licensees are working out of a home office. In many cases, a licensee who works out of their home may qualify to deduct expenses related to their home office, as an offset against their trade/business income for the services they render.

However, to qualify for the home office deduction:

  • a portion of the home needs to be used exclusively and regularly for the licensee’s brokerage business;  and
  • the use of the home office need to meet one of three business activity standards.

For tax purposes, a real estate licensee is considered self-employed, also called an independent contractor, when:

  • they are licensed as a broker or sales agent;
  • the compensation they receive is based on completed transactions, such as sales and other brokerage services (called contingency fees), in contrast to an hourly wage or salary; and
  • a sales agent or broker-associate has a written agreement with their employing broker stating the licensee is an independent contractor for income tax purposes. [Internal Revenue Code §3508(b)(1); See RPI Form 506]

Both broker-associates and sales agents employed as independent contractors qualify for the home office deduction under the same rules. When the licensee qualifies for the home office deduction, the deductible home office expenses include:

  • direct expenses attributable to the home office area used exclusively for business; and
  • indirect expenses, limited in amount to the percentage figure representing the portion of the square footage in the  residence used as the home office.

Direct expenses, deductible as a brokerage business expense, include the cost of decorating and repairs made in the portion of the residence exclusively used as a home office.

The entire amount of direct expenses is deductible from business income without allocation for the personal use of the remaining space in the residence.

Equipment purchased in connection with a business, even when the licensee operates the business out of a home office, is fully deductible in the year purchased. The equipment needs to be both ordinary and necessary to operate the home office. Equipment need not be indispensable to be necessary — the cost of purchasing a printer, for example, is fully deductible.

Extraordinary expenses, such as the purchase of a car for use during the course of business, are not deductible in the year the expense is made. Rather, costs for these expenses are recovered through annual depreciation deductions. [Internal Revenue Service Publication 535]

Indirect expenses, which are prorated, include costs incurred in the upkeep and operation of the licensee’s entire residence, such as:

  • rent paid as a tenant;
  • mortgage interest;
  • real estate taxes;
  • home insurance;
  • utilities; and
  • maintenance.

The portion of indirect expenses deductible as a business expense is calculated based on the percentage of the residence used as a home office.

For example, a licensee exclusively uses 300 square feet of their residence as their home office. The total area of the residence is 1,800 square feet. Thus, the licensee’s home office is 16.7% of the total square footage of the residence.

The licensee’s indirect annual expenses — incurred as ownership and operating expenses on the entire residence — include:

  • $15,000 in mortgage interest;
  • $2,000 in real estate taxes;
  • $3,600 in utility payments; and
  • $900 in insurance costs.

The total amount of indirect expenses is $21,500.

The licensee can write off $3,590.50 as indirect business expenses, 16.7% of the $21,500 residence expenses. [Internal Revenue Service Publication 587] [See RPI Form 506]

In lieu of ownership expenses, when the licensee is a tenant in a home or apartment they use in part as their office, they may write off a pro rata amount of the rent as a business expense. [Visin v. Commissioner (2003) 86 TCM 279]

Expenses outside of the dwelling incurred for lawn care, pool maintenance or tree trimming cannot be deducted as business expenses. Further, expenses unrelated to the home office area incurred inside the house —such as the remodeling or maintenance of any area other than the home office area —  are not deductible. [Internal Revenue Service Publication 587]

Conversely, when the licensee paints and carpets only the home office area, the entire cost of painting and carpeting the home office area is deductible as an expense directly related to the home office.

Exclusive and regular use 

Before the licensee can deduct any home office costs as business expenses, the home office area needs to be used exclusively and regularly for their business.  [Internal Revenue Code §280a(c)(1)]

However, to take the home office deduction, the licensee’s business conduct still needs to meet one of three standards:

  • the home office is used as a place of business to meet or confer with clients;
  • the home office is located in a separate structure not attached to the residence; or
  • the home office is the principal place of business for the licensee. [IRC §280A(c)(1)(A-C)]

A licensee who uses their home office to meet and confer with clients needs to document the client conferences in a calendar or log book, including:

  • their clients’ names;
  • the date of each client meeting; and
  • what they discussed or acted on.

To qualify for the deduction of home office expenses based on its use as their principal place of business, the licensee needs to perform most or at least the most important of their brokerage activities while working in the home office, such as:

  • soliciting and coordinating client contacts;
  • preparing agreements, disclosure documents and advertising copy;
  • organizing and scheduling brokerage activities;
  • maintaining files and records; and
  • regrouping after collecting information, investigating property and records, and meeting with clients during the course of business.

Obtaining signatures on documents, inspecting property and meeting with others at locations outside the home office are essential, but not the most important aspects of a licensee’s business.

A licensee with both a home office and a commercial office may still qualify for the deduction of home office expenses. However, the licensee still needs to meet one of the three qualifying standards, including the exclusive and regular use of the home office for real estate-related activities.

Even though many licensees have a commercial office for professional reasons, when a licensee conducts the most important parts of their work in the home office, they may qualify for the home office deduction. A licensee who makes more substantial use of their commercial office than of their home office, however, does not. [Beale v. Commissioner TC Memo 2000-158]

Licensees and the home office 

Although many brokers work for themselves, broker-associates and sales agents always work as employees of the broker who hired them.  Typically, they maintain a desk in their broker’s office. The broker’s employment and supervision of a licensee, mandated by state law, does not limit the ability of the broker-associate or sales agent to qualify for the home office deduction.

As long as a sales agent or broker-associate qualifies as an independent contractor with their broker, they may deduct home office expenses.

The independent contractor tax status of a broker-associate or sales agent is established by a written employment agreement between the licensee and the employing broker. The agreement states the licensee is considered an independent contractor and will pay their own income taxes without the broker withholding. Nothing more is required to establish their independent contractor status for tax purposes. [See RPI form 506]

Deduction limitations

Consider a real estate licensee who uses their residence as their principal place of business. Each year, the agent writes off home office expenses as a deduction from their brokerage income.

The agent’s real estate business suffered a net loss during the past year. That loss included home office expenses.

However, real estate business losses, which include home office expenses, are limited by the IRS. Losses cannot be taken to the extent they contain home office expenses. Thus, no portion of the reportable business loss may include home office expenses. [King v. Commissioner TC Memo 1996-231]